While the improved global market performance in the first half of 2013 offered hope for an economic recovery, volatile economic conditions in Canada persist. Given the uncertain climate, the Bank of Canada indicated in October 2013 that interest rates would remain unchanged in the near future.

Similar pronouncements were made in the US, a market representing a significant portion of the fixed-income investments in Canadian life insurers’ investment portfolios. The Federal Reserve also reaffirmed plans in October 2013 to continue quantitative easing, dimming prospects for higher interest rates south of the border, as well. Although economic activity has improved, the Fed has stated that it will “proceed cautiously” in decreasing its assets purchases in 2014.

In Europe, a different story is in play: waning growth and inflation are pressuring the European Central Bank to cut interest rates to preserve the current economic recovery. However, with rates already at historic lows, the Bank’s options are limited. Factors such as unemployment, austerity programs (to reduce budget deficits and sovereign debt) and the rising euro are contributing to the eroding investment propositions in several European countries.

Insurers realize their business strategies must effectively take into account the continuing low interest rate environment. Although the long-term expectation is for interest rates to rise, life insurers must make timely decisions that address the current subpar yield conditions.

The key challenge for insurers continues to be their limited ability to reduce interest rate risks for savings- and investment-oriented products. Most insurers in recent years have reviewed their existing product portfolios to reprice or eliminate their high-risk, capitalintensive and low-margin products, while also seeking profitable ways to maintain or gain scale. On the asset side, many insurers continue to contemplate increasing risk in their asset portfolios as a way to obtain higher yield.

The renewed focus on asset management and wealth management (and less interest in costly and risky guarantees) compels life insurers to develop more innovative, attractive products. Companies must continue such innovative pursuits to improve profitability in areas such as tax strategies, sales force management and asset liability management.

The increase in equity and credit market volatility over the past few years is another front-burner issue. It is now clear that these risks were not well understood or priced appropriately prior to the financial downturn. The income from products involving assetbased management fees has been unstable, causing earnings to decline at a time when hedging programs are less effective and more expensive. Consequently, the industry must decrease its risk exposure while enhancing product and service features that appeal to consumers.

To allow for these product adjustments, most insurers have made the following changes:

Increasing the fees on variable products to reflect the cost of hedging in the volatile economy

Restricting investments that limit the amount of risk assumed by customers

Implementing automatic rebalancing to protect customers from significant asset value movement, which also stabilizes the insurer’s fee income

These various product-oriented techniques help limit the exposure to an insurer’s capital and economic position while providing the services that customers expect, i.e., bearing the risks they are unable to bear. By reducing volatility for customers — and insurers — they have been well-received.

By marketing simpler, flexible products with clearer, comprehensible value propositions, and by removing product characteristics that buyers dislike, insurers can effectively grow the top line. For instance, whole life insurance and term life insurance continue to be popular with consumers because of their easy-to-understand, straightforward value propositions. On the other hand, participating products are attractive from an insurer’s perspective, while providing customers with the potential for upside risk.

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